The present invention relates to a method and apparatus for setting prices, of particular but by no means exclusive application in the price setting of financial instruments.
The existing method for setting the prices of, for example, financial instruments varies from either a “black box” approach or a manually intensive approach requiring significant human intervention. For example, before shares of companies are listed on a stock exchange, a panel of securities dealers confer with various investors before setting an offering price. In the case of some fixed interest securities, an auction—requiring staff to take the orders of various institutional and retail investors—is conducted to determine the ultimate price of the securities.
Both of these procedures result in less than optimal outcomes for all participants. For example, the issuers of financial instruments will not know how much money will be raised (in the case of shares) or what interest rate they will have to pay (in the case of fixed interest) until the actual date of issue. At the same time, although interested investors will have an idea of what they believe the securities are worth, the ultimate price on which to base their assessment will not be known until the closing of the transaction. For securities dealers that are acting as intermediaries between issuers and investors, discussions on what price or interest rate the issuer is willing to bear and what price the investors are willing to pay only provide a far from reliable indication.
There are severe consequences for all parties if this price setting procedure is not handled correctly. For example, a company may only wish to sell shares in the company if the price exceeds some minimum price. If the price of these shares falls below the minimum threshold level on the day of closing the transaction, the issuance may be cancelled resulting in wasted costs as well as other less tangible costs (such as damaged reputation). Alternatively, if the pricing is set too low, then the issuer will not have raised the maximum possible proceeds, as a share that experiences spectacular gains on its first day of trading implies demand far outstripping supply. This often occurs, and it is not unknown for a particular issue to be as high as ten times oversubscribed.
At present, securities dealers employ a number of procedures to help address these shortcomings of the existing book building system. For example, many securities dealers have “greenshoe” provisions, where a securities dealer will purchase shares to help support the stock price if the original pricing was incorrect. In many instances, large institutional purchasers will immediately sell their shares looking to turn a quick profit. This damages the performance of the shares and causes undue volatility in the prices of financial instruments.
Consider the following situation. A private, medium-sized domestic transportation company, ABC Transport Ltd, has determined its customers are increasingly doing more cross-border deliveries. After extensive partnership discussions, the company has decided to establish international operations on its own. However, the company needs to raise capital to fund its expansion. The company approaches a securities dealer for advice.
The company has the option of issuing more shares to raise equity capital or it can borrow by issuing notes and paying an annual interest rate. The company has estimated that it will require $50 million for its purposes. After considerable thought, the company decides to issue additional shares in the company.
Since this is a new company, the securities dealer must first estimate the value of the company. This involves engaging various third party service providers such as accountants to review the financial statements of the company, independent valuers and in some cases industry consultants to project future operating results. These results are typically published as a prospectus that can be distributed to any interested investors.
When the prospectus is completed, the securities dealer as well as the issuer will then estimate a price for the shares of the company. This share price estimate will be communicated to prospective investors and interest for the share issue will begin to be tabulated by the securities dealer (i.e. “book building”). Early interest from various investors will provide some indication whether the set price of the shares is acceptable. In many cases, the indicative share price will vary from securities dealer to securities dealer in the lead-up to the actual listing of the shares.
The share price during this period is adjusted based on the experience of the securities dealer. Also, prior to the listing of the shares, the securities dealer is inundated with telephone calls and faxes from the issuer and the investor community for the latest updates on share price and share availability.
As the shares begin trading on a stock exchange, the issuer is hoping they have raised the maximum amount of proceeds from selling interests in itself to the public, the investor is hoping they have purchased a good investment at the right price and the securities dealer is hoping everything goes off without a hitch as its reputation is at stake.
Getting the share price right is critical if the interests of all parties are to be met. Many times, the share price can double or even triple on the first day of trading. This would imply that the company may not have raised as much cash as it could have as investors appear to have been willing to accept a higher price. In some cases, the share price can fall on the first day of trading. In this situation, investors may feel cheated and any future fund raisings by the issuer may be poorly greeted. In both situations, the securities dealer's business would also suffer. It is more often the case than not that financial securities are not priced perfectly.
It is an object of the present invention therefore to provide a method and apparatus for setting a selling price by employing input from prospective purchasers.